China: Introduction On A Tax Law Case Concerning Overseas Merger

Last Updated: 17 January 2018
Article by Shimin Law Offices

i. Facts

On September 29th 2005, Italy Ilva Saronno lnvestment Company Limited (hereinafter referred to as "Italian IC"), officially approved by the Cooperate Office of Foreign Trade and Economy of Shandong Province, acquired for an consideration of RMB 481,424,260 yuans 33% out of Yantai Zhangyu Group Company Limited (hereinafter referred to as "Yantai Zhangyu Co") equity shares.

On July 17th 2012, Italy Ilva Saronno Holding Company (hereinafter referred to as "Italian HC") and Italian IC, accordingly and respectively to a resolution of the General Shareholders' Meeting, decided to carry out a merger: Italian HC accepted Italian IC's whole capital and responsibility, among those including Yantai Zhangyu Co's 33% equity shares.

After the merger operation, on November 21st, 2012, Italian IC was legally deregistered, thus Italian HC being the direct holder of Yantai Zhangyu's aforementioned shares.

On July 17th, 2012, Italian HC informed Yantai Zhangyu Co by letter, explaining the circumstances and mechanisms of the operated merger. Italian HC considered, in accordance with the Notice of the Ministry of Finance and State Administration of Taxation on Certain Issues Concerning the Handling of Enterprise Income Tax in Enterprise Reorganization (hereinafter referred to as Cai Shui [2009] No. 59)1, that according to the general rules of enterprise reorganization regarding merger operation2, they would enjoy the conditions of a preferential treatment by the tax administration; hence, this very one transaction shall not be subject to tax.

The State Administration of Taxation of Shandong Province, Yantai City, Zhifu District (hereinafter referred to as "Zhifu SAT") considers that aforementioned merger essentially establishes a direct transfer of the equity interest and this very transfer's price fails to conform to the independent trading principles; according to the People's Republic of China's Taxation Legal Regulations in force, this very one transaction would be subject to tax. On September 9th 2013, the State Tax Administration of Yantai released a notice (2013 No. 002) concerning tax issues on the basis of the stipulations of article 7 of the Guo Shui Han [2009] No. 698 , carrying out a tax adjustment based on Yantai Zhangyu Co's net assets (RMB 2, 863, 169, 524.88 Y) dated Jun 30, 2012, and Italian HC was required to pay the enterprise income tax RMB46,342,168.32 before September 25th, 2013. On September 22th, the required amount of RMB 46, 342, 168.32 Y was paid by the plaintiff.

Nevertheless, Italian HC remained unconvinced by the above-mentioned notice, and demanded its administrative reconsideration by the National Administration of Taxation of Shandong Province, Yantai City (hereinafter referred to as "Yantai SAT) on Nov.20, 2013, with the purpose to have it revoked. After the reconsideration, above-mentioned notice was maintained by Yantai SAT.

Italian HC still disapproved such a statement, bringing an administrative case on April 24th 2014 to the People's Court of Shandong Province, Yantai District, Zhifu District (hereinafter mentioned to as "Zhifu Court") in order to ask for the cancellation of the State Tax Administration of Yantai Notice and the refund of paid enterprise income tax.

ii. The Key Points of the Judgment

According to Zhifu Court, this lawsuit raises three contentious key points: the first point is to decide whether the reorganization of this transaction should be considered as a merger or a transfer of equity shares. The second point is to verify if the aforementioned reorganization complies with the rules of preferential tax treatment stipulated in Document No. 59 of the Ministry of Finance. Finally, the third point is to know whether the plaintiff, based on the Sino-Italian Tax Agreement and the Sino-Finnish Investment Agreement's most favored nation trading status stipulations, shall enjoy preferential tax treatment during this very transaction. 3

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1 Article 5 of Document Cai Shui [2009] No. 59

Special taxation provisions shall be applicable when enterprise reorganization satisfies the following conditions simultaneously:

(1) Having reasonable business purpose without taking deduction, exemption or deferment of tax payment as the primary purpose.

(2) The proportion of the assets or equity purchased, merged or separated confirms to the proportion prescribed by this Notice.

(3) Maintaining the original substantive business activities for 12 consecutive months after the enterprise reorganization.

(4) The amount of payment of equity interests involved in the consideration in reorganization confirms to the proportion prescribed by this Notice.

(5) The original main shareholders who have obtained the payment of equity interests in enterprise reorganization may not, within 12 consecutive months after the reorganization, transfer the equity obtained.

2 Article 1 of Document Cai Shui [2009] No. 59

The term "enterprise reorganization" mentioned in this Notice means transactions other than an enterprise's daily operation activities, which greatly change its legal structure or economic structure, including change of legal form of enterprise, debt reorganization, equity acquisition, asset acquisition, merger, split-up, etc.

(3) "Equity acquisition" means a transaction that an enterprise (hereinafter referred to as the "acquiring enterprise") purchases equity interests of another enterprise (hereinafter referred to as the "target enterprise") for the purpose of controlling the target enterprise. The payment of consideration by an acquiring enterprise may be in the form of payment of equity interests, payment of non-equity or combination of both.

(5) "Merger" means that one or more enterprises (hereinafter referred to as the "merged enterprises") transfer all of its or their assets and debts to another existing or new enterprise (hereinafter referred to as the "merging enterprise"), and the merged enterprises obtain in return the payment of equity interests or non-equity interests from the merging enterprise, thereby realizing the legal merger of two or more enterprises.

3 In accordance with the first item of Article 3 of Agreement between the Government of the People's Republic of China and the Government of the Republic of Italy Concerning the Encouragement and Reciprocal Protection of Investments

The treatment accorded to the investments by nationals or companies of either Contracting Party (in the territory of the other Contracting Party) shall not be less favorable than that accorded to the investments by nationals or companies of any third State.

the second item of Article 3 of Agreement between the Government of the Republic of Finland and the Government of the People's Republic of China on the Encouragement and Reciprocal Protection of Investments:Each Contracting Party shall accord to investments by investors of the other Contracting Party treatment no less favorable than the treatment it accords to investments by its own investors with respect to the operation, management, maintenance, use enjoyment, expansion, sale or other disposal of investments that have been made. In this case, Italian holding company holds the opinion that special taxation provisions shall be applicable as he believes he should enjoy the treatment for investing in China no less than the treatments Finland (the third country) enjoys, which is no less than the treatments Chinese investor enjoys.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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